Essar Steel’s Insolvency: Final Lap?

The Supreme Court bench, headed by Justice Rohinton Nariman, will begin the hearings in the Essar Steel insolvency case starting Tuesday. The financial creditors of Essar Steel are agitating against the National Company Law Appellate Tribunal’s decision of putting the secured, unsecured and operational creditors on the same footing. The amendments to the Insolvency and Bankruptcy Code that came in response to the NCLAT ruling have prompted the operational creditors to challenge their constitutionality before the apex court.

Financial Creditors’ Case

Essar Steel was one of the 12 large corporate accounts shortlisted for insolvency proceedings by the Reserve Bank of India in June 2017.

In July this year, the NCLAT had approved ArcelorMittal’s Rs 42,000-crore bid for Essar Steel but had changed the allocation of funds between creditors. The NCLAT had held that the credit hierarchy provided for under the IBC has to be applied if the insolvent company is facing liquidation. At the resolution plan stage, the NCLAT had laid down, there cannot be any discrimination between secured, unsecured or operational creditors. The appellate tribunal had also said the Committee of Creditors has no role in distribution of claims from the resolution plan, and it can only decide on the viability and feasibility of the bid.

And so, it had proposed an equal recovery of 60.7 percent for secured, unsecured and operational creditors of Essar Steel. The financial creditors have challenged this conclusion of the NCLAT.

Besides distribution of bid amount, the financial creditors are also challenging the NCLAT’s view on guarantees and indemnities given by Prashant Ruia—Essar Steel’s promoter. The NCLAT had held that Ruia’s right of subrogation has become ineffective since Essar Steel’s debt has been cleared under the resolution plan.

Both the guarantee and indemnity, the NCLAT had said, become ineffective once the financial creditors are paid under the resolution plan. This conclusion has implications not just for Ruia but lenders as well. If the guarantee deed becomes ineffective, it means lenders cannot go after Ruia for the remaining amount of their debt, Sudipta Routh, partner at IndusLaw, had told BloombergQuint.

The key arguments of the lenders on this issue are:

• Guarantors don’t stand absolved when the resolution plan for the principal borrower is approved unless the plan gives full payment to financial creditors.
• Liability of guarantor is co-extensive with principal borrower. Hence, till the entire debt is paid off, guarantor is jointly and severally liable to pay.
• Section 31 of IBC makes an approved plan binding on all, including guarantors. And so, variance of terms of guarantee on account of principal borrower doesn’t absolve guarantor from his liability to pay.
• The liability of a guarantor continues when principal borrower is discharged by operation of law like a court-approved bankruptcy.

Operational Creditors’ Case

Soon after the NCLAT ruling, the Parliament had approved several amendments to the IBC. The amendments prescribed the minimum threshold for payment to operational creditors and empowered the CoC to determine distribution of claims while taking into account the priority and value of the security interest of secured creditors.

As per the amendments, payments to operational creditors for their debt shall not be less than:

• The amount to be paid to such creditors in the event of liquidation of the corporate debtor, or
• The amount that would have been paid to such creditors if the distribution was done based on the priority under Section 53(1), whichever is higher. [Section 53(1) lays down the order of priority of creditors at the liquidation stage—insolvency process costs, dues of workmen, secured creditors, unsecured creditors, statutory dues and then operational creditors.]

An explanation to this section reads: For the removal of doubts, it is hereby clarified that a distribution in accordance with the provisions of this clause shall be fair and equitable to such creditors.

The operational creditors, in their petition before the apex court, have challenged the constitutional validity of the amendments arguing that they violate Articles 14, 19(1)g and 21. BloombergQuint has reviewed a summary of the writ petition filed by the operational creditors stating that:

• The Parliament has ‘failed miserably’ to recognise the difference between the process of resolution and liquidation.
• By no stretch of imagination can a situation be regarded as ‘fair’ and equitable’ if the operational creditors don’t get anything at the cost of financial creditors—who are getting almost the whole pie—in a situation when the corporate debtor will continue to do business.
• It is not as unfortunate a situation where the company is shutting down and the proceeds are being distributed in liquidation. Therefore, the principles of liquidation cannot apply at the resolution stage.
• It is questionable as to whether the Parliament can take away the powers of the court to decide whether a situation is fair or unfair by defining fair and equitable against the fundamental right, and the inherent concept of fairness.
• The amendments are contrary to the Supreme Court’s ruling in the Swiss Ribbons and Binani Industries case where it was concluded that operational creditors must get roughly the same treatment as financial creditors.
• Since operational creditors have no representation on the CoC, there cannot be a fair and equitable distribution—the amendment is framed to take away the rights of operational creditors that have so far been upheld by courts.